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With the savings of hundreds of millions of Europeans threatened, nothing less than an EU level joint recapitalisation of banks is required.

Europe is in the middle of a once-in-a-lifetime crisis. Every European knows what happened when financial markets seized up in the dark years of the 1930s. It is not an exaggeration to say that it could happen again if governments fail to act.

Trust among financial institutions is disappearing and there are risks that fear will spread more widely. Turmoil in financial markets must be stopped before it causes major damage to the real economy. The savings of hundreds of millions of Europeans are directly threatened. If the turmoil produces credit market paralysis, jobs and businesses will be destroyed on a massive scale. A further weakening of the real economy would put more loans at risk and create a vicious cycle of falling asset prices, deteriorating ability to repay loans, and diminishing credit flows.

Actions by US policymakers are welcome, but they are not sufficient. The US authorities learned last week that saving one bank at a time won’t work; a systemic crisis demands a systemic response.

In Europe, saving one bank at a time means either a rescue effort mounted by one nation, despite important spillovers to neighbouring countries, or last-minute improvised coordination and agreement about fiscal burden sharing. The national responses and ad hoc cooperative efforts to date have been useful. Yet interdependence among European banks is too deep for national responses or case-by-case coordination to be enough.

Now is the time to act while the situation still appears manageable. Events in the US demonstrate that financial crises do not evolve smoothly and predictably.

Many solutions will be part of the answer. In the US, dealing with the immediate crisis requires restoring liquidity to money and credit markets, and creating the conditions for the resumption of the securitisation of prime mortgages and other illiquid but sufficiently homogeneous and transparent assets. In Europe, the key problem is high leverage among the internationally active large banks.

Hence the EU contribution must be centred on a recapitalisation of the banking sector, through the injection of public equity or through mandatory debt-to-equity conversions. This has to be done at the EU level (for example, through the EIB). The current approach will lead to a Balkanisation of the European banking sector. Agreeing a harmonised level for deposit insurance would also be important.

To prevent future crises of this nature, regulation of the European financial markets and institutions at the European level will also be required. The problem is not a lack of understanding of how to stop financial crises. The problem is a lack of political will.

Unless European leaders immediately unite to address this crisis before it spirals out of control, they may find themselves fighting over how best to salvage the aftermath.

Alberto Alesina, economy professor at Harvard, Willem Buiter, economy professor at the LSE, and eight other signatories. Reproduced from www.voxEU.org